Chart Of The Week   November 15 2021

Mythbusting The Value Factor

value factor

Intangible investment has become a much larger part of the economy, having surpassed tangible investment in the US in the late 1990s. However, both US GAAP and IFRS are very restrictive on the capitalization of R&D activities, which are known to originate valuable intangible assets. Other types of intangible capital such as unique production processes or customer lists are normally also expensed within SG&A expenses and are never capitalized unless there is an acquisition. This means that both the book value and earnings of intangible-heavy companies could be inadequate estimates of their true intrinsic value.

Indeed, expensive companies generally have higher R&D expenditures as a percent of sales than cheap companies. Importantly, the performance of Value within low R&D stocks is much better than the performance within high R&D stocks. This is in line with the work of Dugar and Pozharny, who found that the value relevance for both earnings and book values has declined for high intangible companies, while it has stayed stable for low-intangible companies. This suggests that traditional valuation measures are losing their relevance as intangible-heavy companies become a larger part of the economy.

The effect of intangibles on traditional valuation metrics can also give us a clue as to why Value has performed well in some industries but not in others. Using a measure of intangible intensity derived by Dugar and Pozharny – which includes identifiable intangible assets, intellectual capital, and organizational capital – we can see that Value has done relatively better in industries with lower intangible intensity while it has performed relatively worse in industries with higher intangible intensity.